Sunday, November 23, 2008

Constructive long-term sentiment readings

Last week the market broke down decisively below its October lows. In the ensuing panic, the S&P 500 melted down (ho hum, what again?) to levels below its 2002 lows.

Amidst the carnage, the market is extremely oversold and long-term sentiment measures are at bear market extremes. With the caveat that long-term sentiment indicators can’t pinpoint the exact low on this bear, this is an indication that downside may be limited for this bear market.

Death of buy-and-hold
Financial planners tell their clients to build an asset allocation plan and to stick with it. However, there are numerous signs that individual investors are abandoning their buy-and-hold discipline. Barry Ritholtz pointed out that AAII data shows that individual investor stock allocations are at levels consistent with previous bear market lows. CNBC recently aired a segment on the Death of buy and hold as an investing discipline.

In conjunction with that news, Mebane Faber's market timing system is shooting the lights out compared to a buy-and-hold strategy, with returns at all-time highs comparable to 1974 bear market low levels. These results are not surprising given the terrible environment for equities.

Market is at oversold extremes
At the time of this writing, most US market indices are down 50-55% from their highs. Bloomberg reports that “[t]he worst annual decline in the Standard & Poor's 500 Index since 1931 has dragged down every industry in the benchmark gauge and 96 percent of its stocks.” Bespoke recently reported that the spread of stocks from their 200 day moving average is consistent levels not seen since the Great Depression. They conducted a recent poll that indicated the consensus low for the Dow is 6,000. Tickersense documents the damage here:

Most notably, the decline in the S&P 500 has been as severe as any of the last fifty years, but it has occurred in half of the time. Typically declines such as the current one occur over two years, this has taken just over one.

They seem to have thrown up their collective hands and moved into panic mode as they went on to say that market history may not provide a good guide anymore.

Speculation is dead
It is said that bear markets don’t die of panic but of neglect and boredom. Trading volume on pink sheet stocks, the most speculative in the US market, are now moribund. A recent Minyanville article reports that:

In October, total dollar volume in over-the-counter stocks fell to less than 0.07% of total NASDAQ dollar volume, the first time it has dropped below 0.1% since the inception of the data in 1995.

A setup for a bottom, but not yet
To be sure, shorter term sentiment indicators such as AAII are not at bearish extremes. Mark Hulbert came to a similar conclusion based on newsletter writer sentiment as well. This readings indicate that the bull is not quite ready to charge yet.

My inner technician's interpetation of these conditions is that there is limited downside in the market. However, equities need to spend some time and base before the bull can revive again.

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